Tag: USA

This Is Why Markets Have Gotten Jumpy

Back in April 2017, the IMF released a Financial Stability Report update which said that “in the United States, if the anticipated tax reforms and deregulation deliver paths for growth and debt that are less benign than expected, risk premiums and volatility could rise sharply, undermining financial stability”.

They said that more than 20% of US firms would find it hard to service their debts, if rates rose – and yes, now rates are rising! This puts pressure on companies, and on their banks.  This is no “flash crash”, it’s structural!

Under a scenario of rising global risk premiums, higher leverage could have negative stability consequences. In such a scenario, the assets of firms with particularly low debt service capacity could rise to nearly $4 trillion, or almost a quarter of corporate assets considered.

The number of US firms with very low interest coverage ratios—a common signal of distress—is already high: currently, firms accounting for 10 percent of corporate assets appear unable to meet interest expenses out of current earnings (Panel 5).

 

This figure doubles to 20 percent of corporate assets when considering firms that have slightly higher earnings cover for interest payments, and rises to 22 percent under the assumed interest rate rise. The stark rise in the number of challenged firms has been mostly concentrated in the energy sector, partly as a result of oil price volatility over the past few years. But the proportion of challenged firms has broadened across such other industries as real estate and utilities. Together, these three industries currently account for about half of firms struggling to meet debt service obligations and higher borrowing costs (Panel 6).

Volatility Rules

The latest print of the VIX or fear index highlights the switch in sentiment over the past week.

Given the ongoing gyrations in the major markets, (US down more than 4% today) it appears that the explanation of the correction as a flash crash thanks to programme trading is too simplistic.

This is going to play out over weeks and months, and it is all about interest rate hikes.

The Bank of England inflation statement over night also underscored rates are on the up, though they kept the rate at 0.5% and movements will be gradual

Any future increases in Bank Rate are expected to be at a gradual pace and to a limited extent. The Committee will monitor closely the incoming evidence on the evolving economic outlook, and stands ready to respond to developments as they unfold to ensure a sustainable return of inflation to the 2% target.

The US T10 Bond Yields are still elevated, and signals higher rates ahead.

The latest data from the US Bureau of Labor  signals more economic momentum, and supports the rate rise thesis.

From the fourth quarter of 2016 to the fourth quarter of 2017, nonfarm business sector labor productivity increased 1.1 percent, reflecting a 3.2-percent increase in output and a 2.1-percent increase in hours worked. Annual average productivity increased 1.2 percent from 2016 to 2017.

See my comments from earlier in the week:

 

US Mortgage Rates Continue Higher Again

From Mortgage Rates Newsletter.

If you thought yesterday was bad for mortgage rates, you’re probably not going to be a big fan of today either.  And since today is the end of a week, we could similarly say you won’t like this week if you didn’t like the previous example.  That’s been true all year so far.  And hey!  Those week’s add up to a month (we’ll give yesterday and today a pass and consider them to be in the first month of 2018) so we can also say if you didn’t like the last month of 2017, you’re really going to hate the first month of 2018.

So what’s going on?  Nothing outside the ordinary.  The only problem is that “the ordinary” has involved bond market participants looking for almost every opportunity to sell bonds, thus pushing rates higher.  Today’s focal point was the big jobs report in the morning.  This data traditionally packs a big punch but it hasn’t been a big market mover recently.  That appeared to change today, but the rate spike had more to do with the fact that traders were intent on pushing rates higher anyway and simply waiting to make sure the jobs data didn’t throw a wrench in the works.  Granted, there was no way to know this would happen before it happened, but in any event, our default stance has been to assume rates will continue higher until they give us clear evidence to the contrary.  Needless to say, we’re nowhere close to amassing any such evidence after days like today.

Rates are now officially at the highest levels in more than 4 years.  The average lender is in the mid 4 percent range when it comes to quoting conventional 30yr fixed rates for well-qualified borrowers.

Federal Reserve restricts Wells’ growth

Responding to recent and widespread consumer abuses and other compliance breakdowns by Wells Fargo, the Federal Reserve Board on Friday announced that it would restrict the growth of the firm until it sufficiently improves its governance and controls. Concurrently with the Board’s action, Wells Fargo will replace three current board members by April and a fourth board member by the end of the year.

In addition to the growth restriction, the Board’s consent cease and desist order with Wells Fargo requires the firm to improve its governance and risk management processes, including strengthening the effectiveness of oversight by its board of directors. Until the firm makes sufficient improvements, it will be restricted from growing any larger than its total asset size as of the end of 2017. The Board required each current director to sign the cease and desist order.

“We cannot tolerate pervasive and persistent misconduct at any bank and the consumers harmed by Wells Fargo expect that robust and comprehensive reforms will be put in place to make certain that the abuses do not occur again,” Chair Janet L. Yellen said. “The enforcement action we are taking today will ensure that Wells Fargo will not expand until it is able to do so safely and with the protections needed to manage all of its risks and protect its customers.”

In recent years, Wells Fargo pursued a business strategy that prioritized its overall growth without ensuring appropriate management of all key risks. The firm did not have an effective firm-wide risk management framework in place that covered all key risks. This prevented the proper escalation of serious compliance breakdowns to the board of directors.

The Board’s action will restrict Wells Fargo’s growth until its governance and risk management sufficiently improves but will not require the firm to cease current activities, including accepting customer deposits or making consumer loans.

Emphasizing the need for improved director oversight of the firm, the Board has sent letters to each current Wells Fargo board member confirming that the firm’s board of directors, during the period of compliance breakdowns, did not meet supervisory expectations. Letters were also sent to former Chairman and Chief Executive Officer John Stumpf and past lead independent director Stephen Sanger stating that their performance in those roles, in particular, did not meet the Federal Reserve’s expectations.

Loan Growth is Uncertain for U.S. Banks

Many U.S. banks reported relative strength in consumer lending in fourth quarter earnings, while corporate lending growth was below expectations, according to Fitch Ratings‘ latest “U.S. Banking Quarterly Comment: 4Q17.”

The industry reported around 3% loan growth for the full-year, well below historical averages. With the passage of the Tax Cuts and Jobs Act (TCJA), it’s unclear if there will be an uptick in lending with fewer incentives for U.S. corporates to borrow.

“Loan growth is expected to remain muted next year as many banks publicly disclosed they are targeting between low- and mid-single digit loan growth for the year,” said Julie Solar, Senior Director, Fitch Ratings.

Tax reform had a significant impact on fourth quarter earnings, but outside of one-time tax charges and gains, most banks reported improving spread income from interest rate increases, still benign credit costs, strong investment banking results and well-controlled core expenses. During earnings calls, many banks disclosed new earnings targets with improved returns. The large regional banks continue to report relatively stronger earnings than the universal banks, though not all banks included in the comment publicly disclosed new targets.

“The TCJA created a lot of noise in the quarter, but going forward most banks will likely report a boost to earnings,” added Solar.

Costs of credit continue to fall well below long-term average with net charge-offs at historically low levels across many asset classes, averaging 44bps during the quarter. This is well below the industry historical average since 1984 of nearly 80bps (which excludes financial crisis era losses between 2008-2010).

The five U.S. Global Trading and Universal Banks (GTUBs) reported strong investment banking and weak trading results during the fourth quarter of 2017 (4Q17), a trend that is unlikely to reverse anytime soon, according to Fitch Ratings’ “U.S. Capital Markets Quarterly: 4Q17“. Growth in debt underwriting from a strong leveraged finance market, an increase in equity underwriting, and growth in advisory drove investment banking (IB) results higher. However, total capital markets revenues in 4Q17 were $22.12 billion; a decline of 10.97% year over year due to weakness in fixed income, currencies and commodities (FICC) net revenue as client engagement levels fell across multiple products.

“Low volatility is problematic for trading, but it does allow corporates to plan for M&A activity which boosts investment banking results,” said Justin Fuller, Senior Director, Fitch Ratings. “Though, the correlation between guidance during earnings calls and future revenue is weak as economic and political variables can often delay deal execution.”

Overall 4Q17 IB revenues were the best fourth- quarter performance in the past five years, with total IB revenues of $8.1 billion, up 19.2% year over year. Overall 4Q17 FICC revenues for all of the U.S. GTUBS declined 30.7% from the prior year to $8.2 billion as continued low volatility drove low levels of client activity.

JPMorgan Chase & Co. (JPM) retained its leading market share position with 23.2% of overall capital markets revenues in 4Q17; however, its overall share declined by 150 basis points year over year, while Bank of America (BAC) achieved year over year share gains of 190 basis points. As a result, the shares of Morgan Stanley (MS), BAC and Citigroup (C) converged at just less than 19% of total capital market fees in 4Q17.

In 4Q17, capital markets revenue as a percentage of total revenue decreased for each firm on a year over year basis. The average contribution to overall revenues of the five U.S. GTUBs was 22.1% in 4Q17, down from 24.9% in the prior year quarter. However, the contribution from capital markets revenue in 4Q17 is only slightly below the five-year average of fourth-quarter capital markets revenue of 22.5%. The five U.S. GTUBs all had significantly higher net interest income this quarter due to higher year over year short-term interest rates as well as incrementally higher wealth/asset management revenues amid higher global equity markets. Fitch believes the strength of these other sources of revenue helps to demonstrate the diversity of the business models of some of the larger banks.

Greenspan Warns Of Rates Rises

Alan Greenspan, the former Fed Chair, speaking on Wednesday on Bloomberg Television said “there are two bubbles: We have a stock market bubble, and we have a bond market bubble”.

This at a time when US stock indexes remain near record highs and as the yields on government notes and bonds hover not far from historic lows.

As the Fed continues to tighten monetary policy, interest rates are expected to move up in coming years.

At the end of the day, the bond market bubble will eventually be the critical issue, but for the short term it’s not too bad

But we’re working, obviously, toward a major increase in long-term interest rates, and that has a very important impact, as you know, on the whole structure of the economy.

What’s behind the bubble? Well the fact, that, essentially, we’re beginning to run an ever-larger government deficit.

Greenspan said. As a share of GDP, “debt has been rising very significantly” and “we’re just not paying enough attention to that.”

“Irrational exuberance” is back!

Fed Holds, But Signals More Rises Ahead

The Fed held their target range but confirmed its intent to lift rates ahead at Yellen’s last meeting as head. The bank signalled that it would push ahead on its monetary policy tightening path as economic activity has been rising at a solid rate, while inflation remained low but is expected to “move up” in the coming months. Most analysts suggest 2-3 hikes this year. The T10 bond yield continues to rise and is highest since 2014. Expect rates to go higher, putting more pressure on international funding costs.

Information received since the Federal Open Market Committee met in December indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. Gains in employment, household spending, and business fixed investment have been solid, and the unemployment rate has stayed low. On a 12-month basis, both overall inflation and inflation for items other than food and energy have continued to run below 2 percent. Market-based measures of inflation compensation have increased in recent months but remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will remain strong. Inflation on a 12‑month basis is expected to move up this year and to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1-1/4 to 1‑1/2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

U.S. Mortgage Rates Can’t Catch a Break

From Mortgage News Daily.

After taking just one day off from the prevailing move higher, mortgage rates were back at it today, heading back to the worst levels in more than 9 months.  The average lender is now back in line with the highs seen 2 days ago on Monday afternoon.  Over slightly longer time-frames, rates have risen an eighth of a percentage point since last week, a quarter of a point from 2 weeks ago, and 3/8ths of a point since mid December.  That makes this the worst run since the abrupt spike following 2016’s presidential election.

Unfortunately, this trend won’t necessarily stop simply because things have “gotten bad.”  While it’s true that the economic effects of higher and higher rates will eventually have a self-righting effect, that could take months–even years to play out.  While this doesn’t necessarily mean that rates will continue a linear trend higher in the coming months, it does mean the current trend is not our friend, and that it would take some huge changes in bond market trading levels before it made sense to lower our defenses.

Rising Interest Payments Are Real

From NorthmanTrader.

Is anyone paying attention? I don’t know, but the cost of carrying debt has been rising and it’s already showing measurable impacts despite the Fed Funds rate still being very low.

My concern of course is that the global debt construct will bring global growth to a screeching halt (see also The Debt Beneath).

As the 10 year is already piercing above the 2.6% area now I want to pay attention to the data coming in as the Fed is dot plotting more rate hikes to come:

After all the Fed has hiked 5 times off the bottom floor in the past 2 years:

Can we see any measurable impact? You bet we can. Here are personal interest payments for consumers:

Mind you we are still near the lows of the previous cycle and already total interest payments are near record highs.

The driver of course is record consumer debt and credit card debt (see also macro charts). But despite rates still being historically low this rise in interest rates has an impact on the consumer.

Already we see this:

“The big four US retail banks sustained a near 20 per cent jump in losses from credit cards in 2017, raising doubts about the ability of consumers to fuel economic expansion. “People are using their cards to get from pay cheque to pay cheque,” said Charles Peabody, managing director at the Washington-based investment group Compass Point. “There’s an underlying deterioration in the ability of the consumer to keep up with their debt service burden.” Recently disclosed results showed Citigroup, JPMorgan Chase, Bank of America and Wells Fargo took a combined $12.5bn hit from soured card loans last year, about $2bn more than a year ago.”

I repeat: “There’s an underlying deterioration in the ability of the consumer to keep up with their debt service burden.”

That’s a problem given the Fed’s dot plot. Before you know it consumers will be handing over a good portion of their tax cuts to credit card companies. Winning.

Is the government carrying record debt immune to this? Nope. Here’s the latest monthly Treasury statement:

Interest on debt alone was $32B for 1 month. During the same month the year prior it was $25B:

That’s a 28% increase year over year. Perhaps the data is lumpy month to month, we’ll see confirmation in the next few months. But much of this US government debt has to be refinanced in the next few years, meaning it will be subject to much higher rates and the US needs to continue to add to its debt to keep itself financed..

Indeed the recent tax cuts only exacerbate an already existing debt sale schedule:

“Economists with Deutsche Bank expect the extra debt the Treasury must issue to fund President Donald Trump’s tax package and the amount of debt the Federal Reserve plans to redeem at maturity this year will bloat issuance to about $1tn in 2018. That’s up more than 50 per cent from a year earlier and, when coupled with a 30 per cent rise in the amount of corporate debt that’s due to mature, leaves questions of who the eventual buyer will be.“

A good question indeed. That’s a lot of debt issuance:

Somebody has to buy it or the pain is real:

“If demand for US fixed income doesn’t double over the coming years then US long rates will move higher, credit spreads will widen, the dollar will fall, and stocks will probably go down as foreigners move out of depreciating US assets,” Torsten Sløk, an economist with the bank, said.”

No, we can all pretend rising rates don’t have an impact, we can also pretend deficits don’t matter, and we can also pretend money grows on trees.

But we can’t pretend interest payments aren’t rising. Because they are. Right now.

Are US Rates Going Higher?

The 10-Year US Bond yield is moving higher.  This is important because it has a knock-on effect in the capital markets and so Australian Bank funding costs, potentially putting upward pressure on mortgage rates.

Whilst the US Mortgage rates were only moderately higher today, the move was enough to officially bring them to the highest levels since the (Northern) Spring of 2017.

So this piece from Moody’s is interesting.  Is the markets view that rates won’t go higher credible?

Earnings-sensitive securities have thrived thus far in 2018. Not only was the market value of U.S. common stock recently up by 4.5% since year-end 2017, but a composite high-yield bond spread narrowed by 23 basis points to 336 bp. The latter brings attention to how the accompanying composite speculative-grade bond yield fell from year-end 2017’s 5.82% to a recent 5.72% despite the 5-year Treasury yield’s increase from 2.21% to 2.39%, respectively.

Thus, the latest climb by the 10-year Treasury yield from year-end 2017’s 2.41% to a recent 2.62% is largely in response to the upwardly revised outlook for real returns that are implicit to the equity rally and the drop by the speculative-grade bond yield. The 10-year Treasury yield is likely to continue to trend higher until equity prices stagnate, the high-yield bond spread widens, interest-sensitive spending softens, and the industrial metals price index establishes a recurring slide. In view of how the PHLX index of housing sector share prices has risen by 4.5% thus far in 2018, investors sense that home sales will grow despite the forthcoming rise by mortgage yields.

Moreover, increased confidence in the timely servicing of home mortgage debt has narrowed the gap between the 30-year mortgage yield and its 10-year Treasury yield benchmark from the 172 bp of a year earlier to a recent 152 bp. The latter is the narrowest such difference since the 150 bp of January 2014, which roughly coincided with a peaking of the 10-year Treasury yield amid 2013-2014’s taper tantrum.

Do suppliers of credit to the high-yield bond market and mortgage market correctly sense an impending top for benchmark Treasury yields? If they are wrong and the 10-year Treasury yield quickly climbs above its 2.71% average of the six-months-ended March 2014, they will regret having acquiesced to the atypically thin spreads of mid-January 2018.